‘Financial crisis a distant memory’ reads a headline in today’s The Australian.
That seems to be the consensus opinion. The ‘GFC’ – as it is flippantly referred to in Australia – visited our shores briefly, and then departed…never to return.
When you’re walking around in the underbrush, the canopy of trees tends to block the light. Only a few slivers make it through. It can be dark and dangerous down there.
But that’s where bankers and analysts are hanging out.
And they’re pretty excited about The Commonwealth Bank’s (CBA) chunky half-yearly result, announced yesterday. Australia’s largest bank made a profit of $3.33 billion in the six months to 31 December.
The result represented a 13 per cent improvement (on a cash basis) on last year. Now that sounds pretty good on the surface but it was driven entirely by further falls in bad debt charges, or impairment expense.
This time last year CBA incurred bad debt charges of $1.383bn against yesterday’s $722m. That’s a $661m improvement.
Moving back up the profit-and-loss statement though, we find that CBA’s operating performance was flat year-on-year. This potentially gives us a sneak preview of what the cash profit growth figure will look like (i.e. flat) at the full year result in August because the big boost to profits from falling bad debt charges is over.
This slow growth future was of little concern to investors yesterday. The share price soared. It appeared as though many were expecting a poor result. Either that, or all those nasty foreigners who are betting on a property market collapse in Australia were forced to cover their short positions.
CBA has 53 per cent of total assets tied up in home loans (total assets includes foreign assets, so as a percentage of Australian assets it would be much higher) making it a target for short sellers looking to profit from falling property prices.
But Aussie property prices will never go down, because: we have China; commodities; a highly urbanised population, coastal living – which is extremely desirable (and therefore more expensive); and oh, yes, an undersupply of housing given our high population growth, which means newly arrived migrants will need to borrow half a million for a shack on the edge of a city…
So the short sellers might be off to lick their wounds for a while, but they’ll be back. The other major ingredient in Australia’s house price miracle is (or rather has been) credit growth.
It has slowed down in a big way.
If banks are vampires, then credit growth is the blood that sustains them. The only way for banks to increase their assets (and therefore profits) is to increase lending. Your debt – whether business, home or personal – is a bank’s asset.
According to a recent release from the RBA, credit growth (it sounds better than debt growth) was just 3.4 per cent in the year to 31December. That’s far from the halcyon days of around 15 per cent growth just before the credit bubble burst.
If the financial crisis is a distant memory, why aren’t we seeing resurgent credit growth?
It’s because the household sector is maxed out. People are saving and paying down debt. The household saving rate is around 10 per cent.
CBA boss Ralph Norris might not appreciate this new frugality (his assets have only grown 4 per cent over the past year) but on the other side of the ledger the inflow of savings (in the form of deposits) takes some pressure off funding costs.
Domestic deposits now fund around 60 per cent of CBA’s assets, meaning the bank has to borrow less from wholesale funding markets, which is a more expensive source of funding.
Keep this in mind next time you hear someone squawking about ‘cash on the sidelines’ just waiting to flow into equities. If everyone takes their cash and buys equities, the banks lose a massive source of funding (assuming those who sell the equities don’t put the proceeds back in the bank!)
Like it or loathe it though, the banks’ profitability is impressive. Return on equity increased to 19.2 per cent, up from 18.9 per cent, for the 2010 financial year.
So good in fact that Ralph Norris doesn’t really want to talk about it. Instead, he wanted to talk return on assets, which was only around 1 per cent.
Of course this ignores the fact that banks are highly leveraged institutions. If return on assets is 1 per cent and return on equity is 19.2 per cent, then you have…leverage, and lots of it.
This is why banks are inherently fragile and cause everyone grief when they take too much risk. It’s also why they should come under greater regulatory scrutiny. Not because they make ‘obscene profits’ – that’s what they’re meant to do.
Henry Kaufman (who was a big hitter on Wall Street for three decades before starting his own research firm in 1988) says it best when arguing for stricter bank regulation:
‘…because financial institutions are entrusted with an extraordinary public responsibility. They have a fiduciary role as the holders of the public’s temporary funds and savings. They generally have large liabilities (other people’s money) and a small capital base and are involved in allocating the proceeds from these liabilities to numerous activities that are critical to the functioning of our economy.’
The only problem is, the regulators haven’t a clue what they are doing or what they are trying to achieve.